2018 Second Quarter

One down, many more to come! As the first quarter has finished for the investors in the Sustainable Dividends Value Fund, it is time for an update. The fund started on January 1st of this year, but the Sustainable Dividends Value strategy already existed before that. Since the start of 2016 I’ve been investing according to this strategy, and now we’re nine quarters down the line. In this newsletter I’d like to briefly touch upon the recent developments in the market and then continue to the performance of the fund. I will devote some attention to what worked and what didn’t work during the quarter. And you will get an overview of how the fund currently looks like. I will finish of with my investment case on Continental. This stock is in the portfolio, and receives a lot of attention due to the increasing focus on electric vehicles and self-driving cars. Enjoy the read!

Market developments
The first quarter was characterized by a high level of volatility of the stock markets. Everything felt quite a bit more uncertain than we were used to in the previous quarters. The reasons are all well known, and were broadly communicated in the media. The most important are the fear for interest rate increases and a global trade war. Both could cause the exuberant economic growth, that we’ve experienced over the last few years, to slow down. For the time being, the fallen share prices have made for an interesting opportunity to buy some additional stocks in the portfolio. All in all, European markets fell just over 4% in the first quarter. The fund had more or less the same performance as the market. After a tough start in January, we completely took back this relative loss in February and March. In the graph below you’ll see the performance of the strategy since the start in January 2016. As a comparison we show the return of the MSCI Europe Index in the same graph. Over the full period our strategy had a return of 25%, while investors in the MSCI index made some 8% return.

What worked and what didn’t?
Let’s start with the latter category. The worst performer in the first quarter was British Mears Group (-19%). This company is specialized in the maintenance work of social housing in the UK, something which is normally quite well predictable. Mears suffered from the fall-out of the fire in the Grenfell Tower in London in 2017. As the owners of social housing shifted their focus from regular maintenance to safety measures, quite some work was cancelled for Mears. Expectations are for some catching-up orders in 2018. Less fortunate was also the price development of ASTM (-15%). This Italian company is managing toll roads in Italy and Brazil. The outlook for interest rate hikes, together with profit taking after a good run for the stock in 2017, made the shares take a bit of a beating. However, the company is profiting from the recovery of the Italian economy and expectations are that Brazil has also seen the worst of its economic disaster. Recently published numbers over 2017 give us quite a bit of confidence in the stock.

Winners in the portfolio
Much more fortunate were the developments with Norwegian Tomra (+25%). The company is the global leader in reverse vending machines. Those machines are being used for collecting and recycling plastic bottles and tin cans. Tomra is profiting from the increasing attention in the world for the plastic waste problem. Especially the announcement from the UK that they’re planning to introduce a scheme in order to recycle all plastic bottles, caused for the share price to jump. Expectations are that during the coming years more countries will follow this example. Tomra will be sure to profit from this development. Dutch Vopak (+9%) was another nice gainer on the stock market. In this case the expectations of higher utilisation rates at the tank terminals for oil and gas made investors enthusiastic. Due to the strategic positions of the tank terminals from this company in almost all major harbour areas in the world, Vopak is very well equipped to profit from the high economic growth rate. The opening of a large number of new tanks will ensure further growth of sales and profits in the coming years.

What does the fund look like?
By far the largest part of the fund assets are invested in companies of which we expect that they will grow profits and dividends in the coming years. The assets are invested in 20 different companies in seven European countries. By choosing stocks in 13 sectors we make sure there is enough diversification in the portfolio. We have a clear preference for sectors that generate stable cash flows. Some sectors were on purpose not chosen in the fund. Banks, for example, are suffering from the ever-increasing regulation of the sector. In general, this is not in their advantage. Pharmaceutical companies are very much depending on the development of new medications. This is hard to predict, making the future cash flows uncertain at best. And stocks of technology companies seem to be very expensive at the moment. As a result, their dividend returns are often very low. The cash position in the fund will be used to add to the portfolio in the quarters to come. Below you’ll find the ten biggest holdings in the fund and their weights in the portfolio.

Electric cars
Finally I would like to share one of my investment cases with you. The fund aims to invest in companies that can help to make our society more sustainable in the long run. Electric cars are an important development and will transform our oil dependant economy in the next decade. Many car companies are busy developing new electric cars. The technology that they use is often not their own. Continental is one of the suppliers, playing an important role in the development of new technologies. You might know the company as a car tire manufacturer. That’s what they’ve been doing for over 100 years. The production of car tires is still important for them, however, is a shrinking part of the overall sales of Continental. Next to car tires the company also designs and produces all kinds of car parts. And for more than 20 years the company has been developing an electric power train for cars. At first this mainly involved the development of engines for so call hybrid cars, with both a combustion engine and an electric generator. Nowadays Continental more and more focuses on developing full electric vehicles. As the price of batteries will come down further in the coming years, the market share of electric cars will go up. Continental is sure to profit from this development.

Autonomous driving
Next to electric vehicles there are more interesting technologies being developed, where Continental plays an important role. Examples are automated braking systems, that make sure you won’t get too close to the car ahead of you. Or radar systems, that keep your car in the right lane. And camera systems, able to give you a 360 degrees view around your car. All is necessary to improve safety on the road, and to make autonomous driving possible in the years to come. These technologies will be used in more and more cars, and Continental will play an important role here. For sure, this is not something that will be realized tomorrow. However, investors with a long term horizon should definitely be interested. Continental is likely to transform into a technology firm over the coming years.

Full year results
In the first week of the year Continental already updated investors on the 2017 results. The official numbers however, where only released last month. Revenues increased by 8% and cash flow by 10% versus 2016. Management increased dividends by 6%. They also provided a first indication of what investors can expect for 2018. In the current book year sales are expected to grow by 7%, with more or less flat margin developments. This seems to be a nice starting point for further profit and dividend growth this year. Unfortunately we didn’t yet get any update on the earlier announced changes in the organisation. The aim is to create more flexibility, and make the company better able to adapt to the rapid developments in the car industry. We do expect to hear more about this in the quarters to come.

Financial health and dividends
Let’s take a look beyond the business model, and for instance spend some time on the financial health of the company. In order to judge this we focus on the Altman Z-score. This ratio predicts the potential of a bankruptcy within two year. A weighted average of five variables gives a good idea of the financial power of a company. A score above 3 is good, while scores below 1.8 indicate a significant risk. Continental scores 3.5, which tells us that the company is in good financial health. The dividend policy of Continental is attractive as well. Although the dividend return isn’t very high, we note that management has increased dividends every year over the last six years. And the average increase has been over 15% a year. Given that the pay-out ratio is close to 30%, the yield seems to be very much sustainable.

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